Credit spreads are one of the most popular instruments used in Option Trading.  The question is why.  It's simple.  The Credit Spread is the easiest spread to understand for beginning option traders, but does this make it a good strategy?

The truth is that Credit Spreads have a high probability to make a profit.  However, along the way to realizing a gain with this trade there is a lot of risk and stress involved.  For example, the average Credit Spread trader will face 100% losses on this trade several times a year while trying to make a modest 5 to 10% a month.  What happens is that eventually all Credit Spread Traders meet their dooms day.  Sooner or later all option traders that use only Credit Spreads wipe out their trading accounts.

Let's look at the "Computer Glitch" of 2010 when the DOW dropped 1000 points in just a matter of minutes.  Those doing Credit Spreads on this day lost on average between 70% and 90% of their portfolio.  What happened is that the volatility rose drastically and the trades moved into that "danger zone" where they lose 100% 10 percent of the time.  The Credit Spread trader doesn't realize that the 10 percent of the time they lose can happen at ANY TIME.  Most people think that they will have 9 wins followed by 1 loss, but this obviously is not how the law of probability works.  It's not uncommon for a Credit Spread trader to face a catastrophic loss on their very first trade, and once this happens, there is no way to recover since a winning trade will only bring back 10% on the remaining capital.

 

Alternative Trades to Credit Spreads

San Jose Options does not teach Credit Spreads.  We use them combined with other spreads and for adjustments, but we never place a credit spread alone.  This is one of the riskiest trades that can be done with options. Our options course is focused on Safety, and we have strategies that help us to protect our capital and keep us away from high risk strategies such as this one.

 

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